The repo sleight of hand at Lehman was an atrocious piece of work. For those of you who haven’t been paying attention here’s how it works.

Lehman had a boatload of assets on its balance sheet supported by a thin slice of equity. To hide their huge leverage, they did deals with counterparties which were essentially short-term (like a week or two) loans against collateral (which they had plenty of). Except, that they didn’t show these as debt on the balance sheet against collateral. Instead they showed them as sale of assets so that the balance sheet at the end of the quarter wouldn’t look as leveraged as it was. Terrible, terrible stuff. The accounting magic may not have been at the scale of Enron, but the end result was the same – a once proud company, bankrupted, it’s shareholders left with nothing.

With all the noise around it, it is almost certain that Dick Fuld, the former CEO will be prosecuted. But what I am unable to fathom is why Ernst & Young gets away with it. Enron brought Arthur Andersen down. Of course they did a lot of other bad stuff like trying to shred the evidence. But does that make so much of a difference to E&Y’s culpability? If the shareholders of Lehman bring a class action lawsuit against Ernst & Young, that could be worth billions in damages.

But that doesn’t seem to be the case. If anyone has a better understanding of this, please leave a comment.

Indeed, the problem when Lehman invented Repo 105 early last decade was that it couldn’t get an American law firm to sign off on it. It finally got the O.K. from Linklaters, a member of the small group of top British firms called the Magic Circle. So Lehman would send over its Repo 105 assets to England, where its European wing handled them. “These firms clearly shop jurisdictions all the time for the most favorable rule set, and there’s nothing wrong with that,” the second executive said.

Also read Felix Salmon’s post on Wall Street bankers still living on a different planet.

In any year if there is a sudden upsurge in income from sale of assets, at least the institutional shareholders or its bankers (leave alone IRS) would trace the cost/year of acquisition of asset, its WDV to determine the profit/loss from such transaction. And Lehman will have to pay tax on that fictitious profits, mind you! Even if Lehmann cooked it all up, in case of doubt, the bank statements for the period should reflect the nature of transaction. A colossal whitewash to the order of $50 billion is possible only if banks, auditors, company managements, employees have all colluded in pulling wool over the eyes of everyone else. In comparison, Satyam looks virtuous…!!! Now we know why big JV agreements insist on having any one of Big Four as their audit firms ;-)))

If you marry on Tuesday night with an explicit agreement to divorce on Wednesday morning, it is prostitution; not marriage. If you sell an asset with a promise to buy back three days later, it is borrowing; not sale/repurchase. It is time accounting went back to principles (and the good old convention of "substance over form") instead of esoteric bright line tests. When sufficiently distressed, people tend to "game the rules".